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About foreign exchange

Foreign exchange refers to the act of converting the currency of one country to the currency of another. Today, foreign exchange — also called forex or FX — generally refers to dealing with international currencies. It can refer to trading currencies, where investors buy and sell different currencies to make a profit, like a stock trader does with stocks, or applying simple exchanges of currencies for personal or business use. Forex can be particularly important if you live or have family overseas, invest in a foreign country or pay clients or suppliers worldwide.

How does the foreign exchange market work?

Currencies are traded regularly through electronic communications networks (ECNs) and by phone worldwide — to the tune of $1.5 trillion daily. The forex market is the largest financial market in the world, encompassing companies investing in foreign companies or services, tourists exchanging their home currency for trips around the world and experts looking to leverage rates to turn a profit.

Factors that affect how a country’s currency trades against another are the sociopolitical atmosphere, prices and inflation rates, foreign trade and monetary policy and export-to-import price ratios. Less-aggressive factors are consumer confidence about the economy and economic growth, the strength of other currencies, investor speculation and day-to-day news about natural disasters, elections and new government policies.

Converting currency

You have many options when it comes to convert currencies, each appeal to a specific situation.

Banks. Nearly all banks offer a selection of currencies that allow you to convert funds. But more exotic currencies may not be available on short notice. Banks typically charge high conversion fees and offer weak exchange rates.

International money transfer specialists. More companies are popping up in the US to offer a full range of forex services with larger varieties of available currencies. These companies typically offer transfer services that allow you can send your money worldwide with competitive exchange rates and low fees, sometimes through peer-to-peer trading.

Foreign exchange kiosks and post offices. Usually found within airports, kiosks run by such companies as Travelex or banks offer foreign exchange services. Your post office may also convert funds to other currencies. Compare the rates and fees you’ll be charged before converting with these services.

Credit and debit cards. Many credit and debit cards automatically convert US dollars into foreign currencies when you’re overseas. You’ll typically pay foreign transaction and ATM withdrawal fees, whereas cards designed for international travel may allow you to lock in currencies at specific rates and waive foreign transaction fees.

“Hedge” your options to save on currency exchange

Many foreign exchange providers offer flexible tools that can insulate you against rapidly fluctuating market exchange rates — and help you better protect when it’s best to complete your exchange. These hedging and planning tools include:

Forward contracts. If the current exchange rate is in your favor, a forward contract could allow you to lock it in for future transaction, sometimes as far as two years into the future.

Limit orders. Specify your ideal exchange rate with a limit order, and when the market reaches that rate, it’s locked in for you to complete your transaction.

Stop-loss orders. A stop-loss order is nearly the opposite of a limit order: Instead of specifying an ideal rate, you indicate a rate you want to avoid dropping below. If the market falls to that rate, your currency is purchased automatically, giving you the potential to profit when the market rises again.

Recurring exchanges. If you need to send regular cross-border transfers — weekly, monthly or quarterly payments to the same recipient — many services will allow you to lock in more favorable exchange rates with lower fees.

How can I hedge with an online forex broker?

To begin hedging your forex trades, you’ll need to:

1. Determine your options. Learn whether your broker offers forward contracts, limit orders, stop-loss orders and hedging tools or find one that does.2. Assess your risk tolerance. No trade carries zero risk, so you’ll need to determine how much risk you’re willing to take.3. Choose two currencies to trade. Consider pairing the “majors” — for example, dollars and pounds — against the euro.4. Contact a forex broker. If you’re a new client or will make ongoing exchanges, ask if you’re eligible for any bonuses or perks.

How do I compare foreign exchange services?

Conversion fees. Most banks and exchange companies will charge a fee for converting currencies. Because these fees can vary wildly, find out whether the provider charges a percentage of the total sale amount when buying or a flat fee, which can be as much as $10 or more.

Exchange rates. Nearly all providers skew exchange rates for a profit. Some add a large margin to the mid-market rate, while more competitive providers will minimize this margin. Exercise your due diligence before going with one provider and you’ll be sure to get more value out of your exchange. Look for the smallest margin between the mid-market rate and the rate you’re offered.

Processing times. Depending on why you’re converting money and how much, how long it takes for your transaction to complete matters. Many companies provide priority services for an extra fee, so be sure to factor this fee into your comparison.

Processing options. You might need to conduct regular transactions if you’re making overseas mortgage payments. If so, add the availability of recurring exchanges to your comparison of providers.

Extras. A providers may offer one-on-one services to business clients along with the ability to negotiate the rate. You might also be able to take advantage of forex market analysis with your foreign exchange provider.

While some providers offer competitive rates but higher fees, others could offer lower fees but weaker rates. Weigh rates and fees against convenience and compare at least three providers — banks and online specialists — before deciding on a service.

What are the pros and cons of foreign exchange?

Pros

Competitive rates and fees are available through specialized money transfer companies.

You can trade currencies to turn a profit.

Cons

Currencies fluctuate daily, which means trading currencies can be risky.

Exchanging currencies can be expensive, depending on the provider.

The market can be complicated and difficult to fully understand.

Frequently asked questions

How long does it take to convert and transfer money across the globe?

Conversion and transfer speeds depend on the currency you’re exchanging and the service you use. You can typically exchange or transfer major currencies in a few days, while more exotic currencies can take up to four days or more.

What is a spot rate?

Many exchange services advertise what’s called a spot rate. This is the value of the currency you’re buying or selling at that moment in time, different from the “forward rate” you’ll receive when actually initiating your transaction.

How safe is a money transfer?

When processed through a reputable bank or company, your funds are safely tracked until in the hands of your recipient. And if you’re sending money internationally, federal protections are in place that require banks, credit unions and money transfer companies to, for example, disclose all fees up front and give you 30 minutes to cancel a transfer, assuming it hasn’t yet been picked up or deposited.

How do I know if my foreign exchange service is safe?

Ensure that your provider is regulated by Commodity Futures Trading Commission (CFTC) and employs online security systems to protect your personal and financial details. If you’re carrying out a money transfer, confirm the service holds your funds in client accounts that are separate from the company’s corporate accounts.

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